Relying on Social Security May Not Be So Smart

What will you do if your Social Security benefit is smaller than you expect it to be?

We’ve all known for years that the Social Security fund would eventually start spending more than it takes in, and could even run dry if adjustments aren’t made. But the possibility really hit home the other day when the Congressional Budget Office announced that payouts would exceed revenue this year. The previous projection had said 2016.

Economic recovery could turn things around. If more people work, more will be contributing to the system, and fewer people will begin tapping their Social Security benefits early. Also, Congress could raise payroll taxes, perhaps just on the wealthy.

But some sort of cutback in benefits may also be part of any remedy. Among the most likely is a change in the way annual benefit increases are tied to inflation. Linking them to the overall inflation rate would produce smaller annual increases than the current system, which is linked to increases in wages.

The average benefit is just more than $1,000 a month. Suppose that fell to $800, adjusted for inflation. What would it take for other savings to make up the missing $200?

It takes a $30,000 nest egg to produce $100 in monthly income. So you’d need to put aside another $60,000.

The $30,000 figure assumes you can withdraw 4% of your holdings a year, and 4% of $30,000 is $1,200, or $100 a month. Why 4%? Because that assumes you earn something like 6% or 7% and reinvest 2% or 3% so your nest egg grows enough to offset inflation. A 4% annual “withdrawal rate” could keep your income flowing, and growing with inflation, for several decades.

Use the Savings, Taxes and Inflation Calculator to see what it would take to amass $30,000. If you had 20 years until retirement, you’d have to save about $150 a month to get a $100-a-month retirement income, even with a fairly decent 6% return. That’s because, with taxes and 3% annual inflation factored in, you’d need about $70,000 to buy what $30,000 buys today. Of course, you’d need twice as much — $140,000 — to make up that missing $200 a month.

We can hope for the best. But for now it seems safer to assume Social Security will get stingier rather than more generous. The people who manage the situation best will be those who start as soon as possible and save as much as they can.